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Tag Archives: Keynes

[St. Louis Fed President James Bullard] notes Keynes’ axiom that governments should borrow to stimulate demand when the private sector falters is being proved false by the way markets are reacting to ballooning deficit spending in Europe.

The [lesson of the] European crisis is “you do not want your country to be reliant on international financial markets to a large degree.”

Like this:

I use basic economic terms quite frequently and it may be useful to set out their definitions:

Consumption ~ is any purchase/sale that is not between entrepreneurs. That is, purchases from entrepreneurs by consumers.

Savings ~ the excess of income over expenditure on consumption. Savings can include debt repayment and money lost or hidden in your mattress — they do not have to be deposited with a bank.

Investment ~ an addition to the real capital stock of the economy. Alternatively, any purchase between entrepreneurs that is not part of user cost.

Income ~ the value in excess of user cost which the producer obtains for the output he has sold.

User cost ~ the measure of what has been sacrificed to produce finished output.

Keynes:

“Income is created by the value in excess of user cost which the producer obtains for the output he has sold; but the whole of this output must obviously have been sold either to a consumer or to another entrepreneur; and each entrepreneur’s current investment is equal to the excess of the equipment which he has purchased from other entrepreneurs over his own user cost. Hence, in the aggregate the excess of income over consumption, which we call saving, cannot differ from the addition to capital equipment which we call investment. Saving, in fact, is a mere residual.”

Richard Koo (The Holy Grail of Macro Economics) points out the flaw in this argument: when savers are forced to repay debt, savings no longer equal investment.

“However when one thinks in truly dynamic terms, income is not all there is to aggregate demand. In a dynamic setting, aggregate demand is not merely equal to income, but to income plus the change in debt.”

American economists, central bankers and fiscal policy makers have reinterpreted British economist John Maynard Keynes’s clever idea that government spending is the best way to counteract a serious economic downturn — and have turned it into a permanent prescription. In their version of the Keynesian theory, declining growth or tumbling stock prices should prompt central banks to lower interest rates and governments to come to the rescue with economic stimulus programs. US economists call this “kick-starting” the economy.

….The only problem is that this method of encouraging growth has not stimulated the US economy in recent years, but in fact has put it on a crash course. From the Asian economic crisis to the Internet and subprime mortgage bubbles, economic stimulus programs by monetary and fiscal policy makers have regularly laid the groundwork for the next crash instead of encouraging sustainable growth. In the last decade, the volume of lending in the United States grew five times as fast as the real economy.